Purchasing and leasing rental property can be a lucrative business. As with any business, metrics should be established and constantly worked toward.
Here are six great metrics that every landlord should know, and seek to refine and improve upon.
1. The Mortgage Payment - This ratio compares your total gross monthly income with your monthly debt obligations. For investment properties, this metric is usually around 45%.
2. Down Payment Requirements - This is another metric where there is a marked disparity between owner-occupied properties and investments. As one would expect, the down payment requirements for investment properties are typically in the 20-25% range, and can sometimes creep up to 40%.
3. Price to Income Ratio - This metric compares the average household price in a given area to the average household income in that same area. To illustrate the importance of this financial metric, the price-to-income ratio in the U.S. was 2.75 before the housing bubble burst in 2008. At the end of 2010, this ratio had fallen dramatically to 1.71.
4. Price to Rent Ratio - This is a metric that compares average home prices and average rents in a certain market. In order to get this ratio, divide the median house price by the median annual rent. As a general guideline, investors should consider purchasing when the ratio is under 15 and renting when it rises above 20. Markets with an inordinately high price/rent ratio are not good investment opportunities.
5. Gross Rental Yield - The gross rental yield for a property is found by dividing the annual rent by the total property cost. Then, the result is multiplied by 100 to yield a percentage. The total property cost includes the purchase price of the property, all closing costs, and any renovation costs.
6. Cash Flow - This is the primary driver behind investing in real estate. If the monthly rent that you collect on a given property is greater than your principal and interest payment (and also taxes and insurance), you should be realizing a net cash flow on a monthly basis from your rental.
As with any business venture, it's important that the real estate investor keeps a keen eye to the numbers. Having a firm grasp of why your venture is profitable or (hopefully not) losing money begins with a conceptual understanding of the figures that are integral to the investment market.
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